My expectation in recent months has been that economic strength, not the much expected weakness, would be the problem for investors in 2010 insofar as it meant a faster monetary tightening cycle and ebbing liquidity across markets. In particular, I've been predicting an aggressive reversal of Chinese policy, as credit growth at over 30% of GDP last year was clearly unsustainable. The Chinese recovery is now pretty clearly a 'V' with Q4 GDP just reported rising 10.7% y/y, and inflation is suddenly a real issue for the first time since Summer 2008, when it almost hit double digits. Food price inflation in China is now 5.3% y/y and as food accounts for over a third of rural household budgets, the PBoC will be under political pressure to restrain the liquidity surge unleashed in 2009. Secular demographic trends are already pushing up nominal wage inflation across the coastal regions to levels not seen in 24 mths, as companies compete for a limited supply of female school-leavers in particular. This combination of a front-loaded cyclical recovery worldwide (and I'd expect an imminent IMF forecast upgrade) with rising inflationary pressures and ultra-loose policy falling behind the economic curve, is a potentially toxic mixture for investors.

Sentiment towards equities globally is certainly extended on every institutional survey I look at. Emerging markets (particularly Brazil) are too popular, and  strong EM balance sheets and earnings outlook are in the price. Fast building inflationary pressures,  the unsustainable path of monetary policy that is set to reverse, and a heavy schedule of new equity supply will all weight on the asset class. Emerging markets ceased outperforming last Autumn, but are still every strategist's favorite asset class. As I said a few weeks back, I'm expecting developed world stocks (and quality in general) to outperform this year. 

Earnings momentum alone won't sustain a further re-rating toward the expensive side of historical valuations against the background of financial market's getting squeezed by increasing competition for capital from the real economy, and central banks withdrawing their life-support measures. Both the HK and Shanghai markets are already reflecting deteriorating liquidity conditions locally (and the recent weakening of the HKD within its trading band is as instructive as the distribution evident in the stockmarket since November). Both markets are leading indicators for a global equity downturn in H1, confounding consensus expectations (but then look at how dollar expectations are suddently reversing course as I predicted) and argue for a defensive and hedged portfolio near-term.